EU carbon market needs quick fix, deep reform

The European Union must agree by the end of this year on a stop-gap measure to tackle the virtual collapse of its main instrument for cutting carbon emissions, the bloc's climate boss said on Wednesday.

Allowances on the EU Emissions Trading Scheme (ETS) sank below €8 a tonne, down more than 6 per cent on the day, reflecting trader disappointment Climate Commissioner Connie Hedegaard's statement on Wednesday did not go further.

Anticipation of EU action to support the market has been behind a slight recovery for the price of an emissions permit from a record low of €5.99 hit in April.

At the start of this week, the Commission, the EU executive, delivered its formal proposal for a temporary withdrawal - or backloading - of some of the huge surplus of allowances generated by economic slowdown that crushed demand.

But while EU officials have always said that far-reaching reforms would require time, the market has been disappointed by their inability to take stronger action quickly. Even the temporary backloading needs to secure approval of member states, which are expected to vote on it next month.

"Market operators must have clarity before year-end on this (backload)," Hedegaard said in the statement.

"Our carbon market is delivering emissions reductions. But because of the oversupply in the market, the ETS is not driving energy efficiency and green technologies strongly enough," she said. "This is bad for Europe's innovation and competitiveness."

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At the root of the problems for a market mechanism that aimed to push the power industry towards cleaner energy by making it more expensive to burn coal, is the original parcelling out of permits several years ago.

Heavy industry and developing markets like Poland demanded higher volumes of permits to allow them to grow and compete. Exacerbated by a weak economy that has reduced demand for electricity, the result is a flood on the market.

The Commission on Monday proposed deferring the auction of 900 million allowances that would have been sold between 2013 and 2015, the first three years of the next phase of the EU Emissions Trading Scheme (ETS), until 2019-20. But it is not yet clear how much support there will be for the plan.

The EU's biggest economy Germany has not taken a formal position and coal-dependent Poland and heavy industry have led opposition to anything that would drive up the price of carbon allowances.

"Poland maintains its negative stance towards any interference with the CO2 permits market that would lead to an artificial rise in their prices," the Polish economy ministry said in a statement.

Energy companies ranging from oil major Royal Dutch Shell to First Solar are among those clamouring for a stronger carbon price to drive innovation and a move away from carbon-intensive coal.

In an open letter, they echoed Hedegaard's call for swift action, as well as deeper reform, "so that the EU ETS as a whole remains the cornerstone of EU climate and energy policy".

Although some market participants had called for deeper cuts to address the allowance glut, the Commission decided on the figure of 900 million allowances because it said this would have a "proportional impact".

It should result in "a more gradual build-up of the structural surplus, thereby reducing the risk of market price volatility in the transition to phase 3," it said. Phase 3 covers the period 2013-2020 for the ETS.

The Commission's views on long-term change for the scheme emerged last month in a draft seen by Reuters.

The difficulty of deeper reforms is that they would take years under EU processes, making it unlikely they could be achieved before the current European commissioners end their term in 2014.

The structural measures include raising an EU target to cut emissions to 30 per cent by 2020, from a current goal of 20 per cent. Debate on increasing ambition beyond existing 2020 green policy goals has stalled so far, with Poland again leading opposition.

Other options include permanently cancelling allowances, rather than just deferring them, and bringing other sectors into the ETS in addition to those, such as industry and utilities, already in the plan.

Adding aviation has met with international fury and the Commission this week announced a plan to freeze for a year the requirement for all flights to and from EU airports to pay for emissions through the ETS. The exemption does not apply to internal EU flights.